April 18 (Bloomberg) -- German bunds outperformed most of
their euro-region peers as fresh concern about Europe’s debt
crisis boosted demand for the safest assets while the nation’s
borrowing costs dropped to a record at a sale of two-year notes.

Italian bonds reversed gains after Prime Minister Mario
Monti pushed back his balanced-budget goal and predicted a
deeper contraction of the economy. Spanish government bonds
pared an advance after the Bank of Spain said the country’s bad
loans ratio climbed. The nation will auction two- and 10-year
securities tomorrow.

“The auction provides further evidence that safety, both
in terms of credit quality and liquidity, remains the overriding
concern for investors as the debt crisis lingers,” Michael
Leister, a fixed-income strategist at DZ Bank AG in Frankfurt,
wrote in a note to investors. “We expect bunds to remain well
supported.”

German 10-year bond yields declined three basis points, or
0.03 percentage point, to 1.72 percent at 5 p.m. London time.
The 1.75 percent security due July 2022 advanced 0.280, or 2.80
euros per 1,000-euro ($1,312) face amount, to 100.257. Two-year
note yields fell one basis point to 0.14, after reaching a
record low of 0.091 percent on April 10.

Germany auctioned two-year notes at a yield of 0.14
percent, an all-time low, according to data compiled by
Bloomberg. The government allotted 4.21 billion euros of the
securities after receiving bids for 7.67 billion euros,
Bundesbank data showed.

‘Close’ to Lows

“We are very close to their lows in yield terms, and there
isn’t much scope for them to fall much further,” Marc Ostwald,
a strategist at Monument Securities Ltd. in London, said about
German bund yields. “There’s a lot of bad news around at the
moment, which gives them some support.”

The two-year German note yield will meet resistance at the
April 12 high of 0.163 percent, according to data compiled by
Bloomberg. Should it rise above that level, it will meet further
resistance near the 50-day moving average at 0.213 percent, and
the 100-day moving average at 0.214 percent, the data shows.
Resistance refers to an area on yield charts where orders to buy
a security may be grouped.

Italy’s 10-year yield rose one basis point to 5.48 percent,
after climbing as much as seven basis points to 5.55 percent.
Spain’s 10-year yields were seven basis points lower at 5.82
percent, after falling as much as 17 basis points.

Balanced Budget

The Italian government, which had vowed to balance the
budget in 2013, now expects a shortfall of 0.5 percent of gross
domestic product next year, the Cabinet said after meeting in
Rome today. The deficit of 0.1 percent previously estimated for
2013 won’t be reached until 2014, it said. It also forecast the
economy will shrink 1.2 percent this year, more than double the
0.5 percent contraction predicted in December, before returning
to growth of 0.5 percent in 2013.

“The deterioration in the growth forecast automatically
implies that the deficit will be higher than forecast,”
Gianluca Ziglio, an interest-rate strategist at UBS AG in
London, said, referring to Italy. “From a market perspective it
pushes the balanced budget back a year and that is negative for
the bonds.”

Spanish and Italian securities have tumbled amid investor
concern that the two economies will struggle to curb their debts
and deficits after a rally inspired by unlimited three-year
loans from the European Central Bank to the region’s lenders
faltered. The two nations’ 10-year yields have jumped almost 100
basis points since this year’s lows of 4.83 percent reached on
March 1 for Spain and 4.68 percent reached on March 9 for Italy.

Non-Performing Loans

Spanish securities have lost investors 1.6 percent this
year, the second-worst performance after Greece, according to
indexes of 26 sovereign debt markets compiled by Bloomberg and
the European Federation of Financial Analysts Societies. German
government bonds returned 0.9 percent this year, the indexes
show, while Italy’s have gained 9.4 percent.

Non-performing loans as a proportion of total lending in
Spain jumped to 8.16 percent in February, the highest level
since 1994, from less than 1 percent in 2007, according to Bank
of Spain data published today. The total credit in the economy
that the regulator lists as “doubtful” is 143.8 billion euros.

Spain plans to sell a maximum of 2.5 billion euros of bonds
maturing in 2014 and 2022 tomorrow, according to the debt
agency’s website. The nation sold 3.18 billion euros of 12- and
18-month bills yesterday, compared with the Treasury’s maximum
target of 3 billion euros.

Volatility in Finnish securities was the highest among
euro-area debt markets, according to measures of 10-year bonds,
two-and 10-year yield spreads and credit-default swaps compiled
by Bloomberg.